Email This Print ThisChairman's Statement

Extracted from Annual Report 2015

Dear Fellow Shareholders,

Regrettably, 2015 was anything but a record year due to the extreme negative industry conditions, which started manifesting themselves in the last four months of 2014 and peaked mid-year.

The combination of overly aggressive rough diamond pricing, with stagnant polished diamond prices, mostly due to slowing growth in demand from China, in particular, resulted in unsustainably low manufacturer margins. The much higher than normal polished inventory levels at FY2014 year's end, mainly due to pipeline skewing driven by extended certification times, and the aforementioned unsustainable margins, complicated further by reduced working capital credit lines available to our customers, led to polished diamond manufacturing activity dropping significantly, by some 30%, in the first half of FY2015. As a result of ongoing lack of profitability, with rough diamond pricing remaining too high, conditions in the diamond industry polishing and cutting segment (the "midstream") further deteriorated mid-year with DeBeers' sightholders refusing unprecedented quantities of offered diamonds (at some sights up to 80%) and manufacturing activity dropping further to below 50% of normal.

Given this background, with little to no incentive to acquire new technology, our sales of new equipment dropped by some 55% year over year. Galaxy™ family inclusion mapping systems sales, one of our primary growth drivers in the preceding years, faltered for the first three quarters of FY2015, but recovered somewhat in the fourth quarter with the introduction of the Meteor™ system. With deliveries in FY2015 of only 25 Galaxy™ family systems to customers and service centres, just over half the number delivered in 2014, the Group had an installed base of 215 Galaxy™ family systems as of 31 December 2015. The Group's recurring revenue (including Galaxy™-related, Quazer™ services, annual maintenance contracts, etc.) also dropped in FY2015, due to subdued manufacturing activity, but by a lesser 25% and constituted over 45% of overall FY2015 revenues.

Industry conditions improved after the Diwali holiday in November 2015, as solid holiday season sales (an estimated 3% increase year over year in the U.S.) and reduced inventory (in fact actual shortages of polished diamonds), as the result of the aforementioned subdued manufacturing activity throughout 2015, gave rise to 3%-5% increases in polished diamond prices. As of this writing, indications are that the oversupply of polished diamonds, which manifested itself at year end 2014, has been worked through the pipeline, with some analysts pointing to the reduction of more than US$ 5 billion in working capital credit to the industry as a key indicator of this. We have, in fact, witnessed a return to more normal polishing activity in the diamond industry midstream, still our primary customer base. Furthermore, DeBeers lowered their rough diamond prices by an estimated 7%-10% (depending on category) at the January 2016 sight, which, at some US$ 540 million, was the largest in more than half a year, a further indication of renewed midstream activity. The February sight provided further indications of the improving midstream industry conditions. In-plan demand for rough diamonds from DeBeers was some US$ 1 billion, with US$ 610 million actually being sold through all their channels. Other mining companies also experienced strong demand and had successful tenders for their rough diamonds, and demand for rough diamonds in the secondary market was exceptionally strong. We thus expect, barring any unforeseen macro-economic shocks or industry-specific negative developments, that the business conditions prevailing in 2016 will be more beneficial to the Group than those experienced during 2015.

It is to be noted that, despite the very challenging industry conditions, the Group's strategy was to continue with its ongoing research and development and sales and marketing efforts so as to advance its long-term goals. In fact, across almost all product lines, planned milestones were achieved with the Advisor™ 6.0 planning software, Meteor™ small stone inclusion mapping system, Sarine Profile™ and non-diamond gemstone processing Allegro™ system all launching successfully.

Group Performance - Year in Review

Revenues for FY2015 were a disappointing US$ 48.5 million, a decrease of 45% as compared to US$ 87.8 million for FY2014. Gross profit for FY2015 decreased by 47% to US$ 32.5 million, as compared to US$ 61.9 million for FY2014. For FY2015 the Group recorded a gross profit margin of 67%, as compared to 71% in FY2014. Profit from operations for FY2015 decreased by over 83% to only US$ 5.5 million, as compared to US$ 32.9 million in FY2014, as the Group's strategy was to continue with its ongoing research and development and sales and marketing efforts, as noted above. The Group thus recorded an operating margin for FY2015 of only 11%, as compared to an operating margin of 38% for FY2014. For FY2015 the Group reported a net profit of a minimal US$ 3.6 million, 87% less than the net profit of US$ 27.2 million for FY2014, and a net profit margin of only 7%, as compared to 31% for FY2014. All these less than desirable financial results were a direct result of the extremely challenging industry conditions in 2015, as detailed above, coupled with our expenditures in adherence to our stated long-term strategic goals.

Significant Events in 2015

  • Release of the Advisor™ 6.0 planning software, with significant additional features, adding to our planning software's value proposition and bolstering our industry-leading status, and a new level of intellectual property protection based on the utilisation of cloud computing architecture. Thus, we have added an additional layer of security to the penetration barrier to would be competition for our industry-leading integrative rough diamond processing solutions.

  • Introduction of the Meteor™ small stone inclusion mapping system, for stones ranging from 20 to 89 points, an addressable segment of some 50 million stones annually. This new member of our inclusion mapping systems family, now offered to our customers in the midsteam, even at its accelerated throughput (almost double the throughput of previously introduced inclusion mapping systems of the Galaxy™ family), expands our addressable market by a factor of three! Furthermore, by taking the technology down to the next tier of rough diamonds, we believe we have further narrowed the window of opportunity for our would-be competition.

  • Sarine Profile™ launched in trial programs with leading industry players – gem labs, wholesalers and retailers in the U.S., both on the national and regional levels, as well as in the Far East, Australia and Mexico. We believe the Sarine Profile™ will enable online transactions with a completely new level of confidence, while reducing costs for both seller and buyer, and will also enhance the in-store buying experience, by empowering the consumer to make a truly informed decision. It also allows chains to offer any stone from their entire (virtual) inventory, to any customer in any store, regardless of its physically being in that specific outlet or not.

  • Opening of the initial Allegro™ high-speed and highly accurate nondiamond gemstones processing system, which transforms the rough stone directly into a fully-shaped (unfaceted) gem, service centre in India.

Looking Ahead to 2016

Going into 2016, industry conditions are markedly better than in late 2014 and throughout 2015:

  • Rough prices have been discounted some 20% – 25% over the past year;

  • Polished prices are up some 3% – 5% (U.S. Census Bureau data show a January increase in diamond jewellery prices of some 7% year over year);

  • Inventories are down significantly with actual shortages in many categories of polished diamonds over 15 – 20 points;

  • Midstream manufacturing margins are back in the black, by some accounts by as much as 10%; and

  • Overall bank credit to the industry is down some 25%, alleviating liquidity issues

Market conditions permitting, we expect to realise accelerated sales of our Galaxy™ line of products and services, as we have now successfully introduced the Meteor™ for smaller rough stones between 20 points (a fifth of a carat) and 89 points, complementing our product line of systems now capable of processing stones from 0.20 up to 200 carats rough (the Meteor™, Solaris™, Galaxy™ and Galaxy™ XL products), an addressable market of some 65 million stones annually, along with optional highresolution scanning (the Galaxy™ Ultra). We continue to closely monitor our would-be competitors from among the other technology suppliers to the industry, and, to the best of our knowledge, there have been no material developments throughout 2015 or in the initial months of this year. We have become aware of clandestine efforts by a lone player in India who operates a number of devices, which seemingly replicate, in whole or in part, the core processes of our inclusion-mapping for Galaxy™-sized stones, without our crucial cloud-protected image processing, without high resolution scanning and without the ability to interface with our latest cloud-protected Advisor™ planning software. We estimate that the throughput of these devices is, in aggregate, less than 5% of the stone quantities regularly scanned by our Galaxy™ systems and have been led to understand that the results are of inferior quality. The Group is pursuing the various legal channels available to it to enforce its intellectual property rights in this regard. Together with our expansive installed base of industryleading planning systems, we believe our competitive edge has, in fact, improved over the past year, having introduced the Meteor™ and the cloud protection for the Advisor™.

Additionally, we have started gaining traction in our polished diamond offerings. Our Sarine Profile™ has been launched in programs with leading industry players – gem labs, wholesalers and retailers in the U.S., both on the national and regional levels, with generally positive feedback, as well as in the Far East (Japan, China, Hong Kong, Singapore and Korea), Australia and Mexico. Some of these pilot programs are, admittedly, very limited in scope, but we believe we are introducing a new concept, with broader capabilities than other offerings, which requires educating the market to its benefits. There is, indeed, growing recognition that imaging technologies are essential marketing and sales tools with the capacity to “show and tell” the polished gem, as well as branding it and differentiating it from the commoditised standard cuts and stones, amongst e-tailers and retailers alike. Dry tabular non-intuitive data, as formulated in the historic four C’s, no longer appeal, nor convince, the younger generation of internetsavvy buyers. The Sarine Profile™ is unique in that it allows each retailer, whether online or brick and mortar, to select its preferred imagery from a toolbox of options including the various levels of imagery produced by the Sarine Loupe™, light performance grading and video generated by the Sarine Light™, and hearts and arrows graphics, Cut proportions graphics, laser inscription viewing, etc., all as derived from our DiaMension™ Axiom, DiaMension™ HD and DiaScribe™ systems, along with other user-provided data, such as the stone’s gemmological laboratory report, retailer promotional material, etc. We believe the Sarine Profile™ will enable online transactions with a completely new level of confidence, while reducing costs for both seller and buyer, and will also enhance the in-store buying experience, by empowering the consumer to make a truly informed decision. It also allows chains to offer any stone from their entire (virtual) inventory, to any customer in any store, regardless of its physically being in that specific outlet or not. We continue to initiate pilot programs with additional customers and additional programs with satisfied customers. Additional technologies which will further enhance the polished diamond’s trade’s transparency and provide supplementary data are in development, including, for example, the announced “fingerprinting” and fine-sorting of a diamond’s Clarity in accordance with industry accepted sub-grades pertaining to the diamond’s actual appearance (e.g., “eye-clean”, “no black inclusions”, “no inclusions under the table”). We expect these services’ volumes, offered on a per-stone basis with the charge based on the selected options from our diverse toolkit, thus generating an additional recurrent revenue stream, to continue to increase throughout 2016.

Finally, we have opened our first two service centres for the Allegro™ processing of non-diamond gemstones in India and Israel, in which we provide inexpensive (equating or below the cost of manual manufacturing) per-stone processing services. The Allegro™ is a high-speed and highly accurate system, which processes non-diamond gemstones and transforms the preformed (i.e., the initial suggested location of the table has been manually identified for colour optimisation) stone directly into a fullyshaped (unfaceted) gem. It thus comprises the functionality of our rough diamond planning systems along with (non-laser) cutting and shaping abilities, to provide extremely accurately sized stones, with minimal weight loss, high throughput and virtually no human error. Furthermore, the machine is configurable to process gems according to varying market preferences. When measured by the number of stones produced annually, the manufacturing market for non-diamond gemstones is significantly larger in volume than that of diamonds, albeit not by dollar value, of course. We expect to expand our presence in 2016 in India, as well as to additional relevant gemstone processing geographies (e.g., Sri Lanka, South America). We expect this venture to start contributing to our revenues and to create a new recurrent revenue stream.

We will focus our R&D efforts primarily on:

  • Enhancement of the Sarine Loupe™ platform to support additional shapes and sizes of polished stones, as well as to develop additional capabilities relating to key characteristics of the polished diamond;

  • Enhancement of our Sarine Profile™ in order to provide additional optional imagery, video and other relevant information for enhanced customer branding of their jewellery lines;

  • Expansion of our Cloud-based infrastructure for the Sarine Profile™, in order to facilitate enhanced downloading and provide for the information management requisite to the continued worldwide rollout of the service; and

  • Upgrading of the Allegro™ system, launched in late 2015, for additional accuracy and higher throughout.

Dividend

The Board of Directors has recommended that a final ordinary dividend of US 1.5 cents per share (approximately US$ 5.2 million) be distributed for FY2015. This will bring total dividends for FY2015 to US 3.0 cents per share, approximately US$ 10.4 million. This is just under three times the net profit for the year.

The Board believes the worst of the industry downturn is behind us. However, the extent and speed of the recovery are not yet clear, nor are the possible effects on our business results of current instabilities in the equity markets and the conversion rates of currencies in our primary markets. Therefore, for FY2016, the Board of Directors has decided to reduce the 2015 declared dividend policy of US cents 2.5 every six months, which was, regrettably, not paid, due to the very challenging industry conditions last year, back to the 2014 dividend policy of US cents 2.0 every six months, subject to semi-annual Board approval, the Annual General Meeting's approval of the final dividend and subject to business conditions, financial results, other pre-empting uses of funds, statutory and tax issues, etc.

Acknowledgements

On behalf of the Board of Directors, I would like to again thank our evergrowing circle of customers, conscientious suppliers and business partners, and devoted management team and employees for their ongoing support of and dedication to the Group. We believe that these long-term relationships, which we have nurtured, have helped us weather the very stormy industry conditions of 2015, and will continue to foster the means by which we will bring innovation and value to the global rough and polished diamond trade in 2016 and beyond, as we inspire confidence in the industry's players, its global consumers and in our loyal shareholders.

Respectfully Yours,


Daniel Benjamin Glinert
Executive Chairman